Nov 7, 2008 | 20:01 GMT

7 mins read

The Western Balkans and the Global Credit Crunch

Talks between Serbia and the International Monetary Fund regarding Serbia's budget will be extended until Nov. 11, the fund has announced. The talks are occurring against the backdrop of the global financial crisis, which has negatively affected the Western Balkans, of which Serbia is a part, in various ways.
The International Monetary Fund (IMF) announced Nov. 6 that talks with Belgrade about how best to design a tight Serbian budget conforming to IMF demands will be extended until Nov. 11. The Western Balkans region — of which Serbia is a part along with fellow former Yugoslav republics Croatia, Bosnia, Macedonia and Montenegro — was a latecomer to the post-Cold War Central European credit explosion. Now that the explosion has become a contraction, the region needs a helping hand. Most countries in the region, including Croatia, began negotiating EU entry in the mid-90s and had joined by 2007. Serbia, Macedonia, Montenegro and Bosnia, however, are particularly at risk from the global liquidity crisis as they lack the protection of EU membership — or even an application for membership. Belgrade hopes to attain a standby agreement from the IMF in case it needs to draw funds from the international body, although Serbia has said it does not need a loan at present. The global liquidity crisis and associated problems in neighboring Hungary and Romania have caused the Serbian dinar to fall to a 29-month low. To prevent capital flight, the Serbian central bank raised interest rates 2 percent to 17.75 percent Oct. 31. For once free of internal political discord, Serbia thus far been the most proactive country in the region at working to stave off financial disaster. Early on in the crisis, it solicited advice from the IMF. Should things get really bad, Serbia therefore already will have done most of the legwork, and the IMF can simply write it a check. Its neighbors — including Croatia, which is well on its way to EU membership — may have much graver financial worries due to a lack of preparation, a particularly large credit explosion and weak economic fundamentals. Credit did not begin freely flowing from Western Europe to the Balkans until after the 2000 revolution in Serbia that ousted strongman and regional troublemaker-in-chief Slobodan Milosevic. With the (somewhat troubled) democratization of Serbia, the largest economy of the former Yugoslav republics, foreign money began entering the region in earnest. But for Serbia, the real flow did not begin until the electoral ouster of nationalist Prime Minister Vojislav Kostunica in early 2008. So while by many economic measures Serbia is the worst off of the Balkan states, it has experienced the smallest credit surge, and so has less distance to fall in the current crisis. Given that Central Europe has not been exposed to a credit boom for as long as its more advanced neighbors, the financial problems plaguing the region are somewhat blunted relatively speaking. Nonetheless, the combination of foreign bank domination of the banking system and weak fundamentals plaguing Central Europe is definitely an issue in the former Yugoslav republics as well. In the Western Balkan region, Croatia is probably the worst off, with a budget deficit of almost 2 percent of gross domestic product (GDP), trade balance deficit of 8.6 percent of GDP and externally held public debt of 44 percent of GDP. Bosnia has somewhat better outlook, though its current account deficit of 16.8 percent of GDP is troubling. Serbia managed a budget surplus in 2007, but in 2008 it ran a budget deficit of 1.7 percent of GDP that is set to increase further in 2009, a contentious point with the IMF. Serbia is also running a high current account deficit of nearly 13 percent of GDP. (One of the main reasons behind the Serbian budget deficit is the promise in 2008 by the governing party to increase pensions, part of a deal with coalition partner the Socialists.) Exacerbating Serbia's, Croatia's and Bosnia's respective troubles is the high percentage of foreign ownership of banks in each country. In Croatia and Serbia, foreign currency lending is particularly high, with more than 80 percent of loans and mortgages in Croatia denominated in either euros or francs and nearly 100 percent of loans and mortgages in Serbia denominated in euros. Foreign-denominated loans allow potential homeowners to take out a loan originally denominated in low-interest-rate Swiss francs or euros instead of the high-interest-rate Croatian kuna or Serbian dinar. Foreign banks, particularly the Austrian, Italian and Greek banks active in the region, have favored this lending mechanism to lure potential customers with low interest rates. But these mortgages are risky. If the kuna or dinar depreciates against the euro or the Swiss franc, the homeowner is left servicing an ever-appreciating mortgage payment — and this is precisely what has been happening. And depreciating currencies is not the only problem that homeowners have to worry about. Due to the instability of the region's currencies, foreign-denominated lending was also popular with business lenders and other consumer lenders (to fund car purchases, for example). With the Serbian dinar already falling against the euro to a 29-month low, many will feel a squeeze on their loans. Tempering the enormous percentage of loans denominated in euros in Serbia is the high rate of homeownership, meaning less than 5 percent of GDP is in outstanding mortgages on the market. (The comparable figure in the United States is closer to 70 percent.) This situation arose because as Serbia transitioned from communism, many residents were allowed to buy up communal property they already lived in at extremely discounted prices. n Croatia, by contrast, exposure to foreign capital and construction of new homes — and thus new home sales — have been going on for longer, so outstanding mortgages stand at more than 10 percent of GDP. This means Croatia could face a proportionally much stronger punch from defaults as the kuna falls as much as the dinar. Meanwhile, Montenegro's main problem arises from its robust GDP growth of 7 percent in 2007, which mainly was fueled by construction boom associated with tourism. Foreign capital — particularly from Russia — had marked Montenegro as the next destination for Europe's very rich, mainly from Russia. This has led to precipitous increases in the value of some Adriatic beachfront property, making it more expensive even than Monte Carlo. The construction industry has boomed as luxury hotels and casinos are rising up on the coast. But the financial crisis has hit Russian oligarchs, associated billionaires and millionaires hard, and could mean knock-on effects for Montenegro as the construction splurge comes to a screeching halt and unemployment associated with the construction industry drops as well. This falloff has impacted Montenegro's banks, where already there have been reports of minibank runs and daily caps on withdrawals. In Bosnia, the exposure to foreign banks and weak fundamentals exists, but the extent of mortgage lending is not nearly as high as in Croatia or even Serbia. Similar to Serbia, Bosnia's weakness is a sort of strength. The Bosnian "government" is divided among three sectarian groups that have little to do with each other, so the country's economic development has proceeded at a middling-to-weak pace since the 1995 Dayton Accords. This means there is simply not a lot of economic activity to stop in Bosnia. For Bosnia, the financial crisis' deepest impact therefore may not come so much in the form of "mere" recession, but in a stark decline in political stability. STRATFOR sources in the region have indicated that NATO is considering slashing its commitments to Bosnia as richer European states affected by the financial crisis look for ways to slim down their national budgets. If they follow through with the threat, Bosnia — the Serbian and Bosnian/Croatian confederate units of which are held together only by the will of the foreign presence in the country — could be destabilized.

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